Can infrastructure provide investment income?

Funds that own infrastructure such as schools and hospitals could offer a
stable long-term income.

It may not sound the most inspirational and exciting of assets classes, but infrastructure is the hot topic in investment circles right now. And if you think it is the domain of big institutions only you might want to think again, particularly if you are after a sustainable income stream.

This week, the Government suggested that pension funds should be more proactive in helping the economic recovery. As a result plans to incentivise pension funds to invest directly in infrastructure development are being finalised by ministers in a bid to kick start the construction industry and boost pension income.

Earlier this month, the Government announced the end of the Private Finance Initiative (PFI), the system that created public-private partnerships to fund infrastructure development in Britain.

PFI contracts under negotiation in March this year included the construction of infrastructure such as hospitals, schools, tram lines, residential homes and street lighting.

Writing in this paper last week, Jesse Norman, MP for Hereford and South Herefordshire, celebrated what he called "the death of PFI".

"PFI has been an enormously costly, inflexible and non-transparent way to procure and manage public infrastructure," he wrote.

Mr Norman called instead for a national infrastructure fund.

Until this fund is created, private investors can still get a piece of the PFI pie – as many current contracts have more than 25 years left to run. PFI may attract criticism, but from a private investor's point of view it can make for an excellent source of long-term, investment-linked income.

Stephen Peters of Charles Stanley explained: "The assets PFI invests in are typically social infrastructure assets – hospitals, schools, prisons for instance – where in return for building and running the assets for a set period of time, typically 25 years, the owners are entitled to receive cash flows from the Government.

"If the assets are available for use, then the owners get paid. Ultimately, at the end of the contract, the asset returns to being owned by the Government, if its management has not been renegotiated in the meantime."

There are a number of infrastructure funds available to private investors.

Investment trusts HICL Infrastructure and John Laing Infrastructure are the two "lowest risk" funds, as almost all their assets are no longer in the construction stage, meaning they are taking no development risk.

Both funds are mostly invested in Britain, but also have investments in Europe and Canada; they pay a yield of between 5pc and 6pc. HICL has returned 35.6pc over the past three years.

It is not just the UK that offers infrastructure investment opportunities.

3i Infrastructure, one of Britain's largest private equity funds, owns PFI assets in Britain, but also invests in Indian infrastructure. It is currently yielding 5pc and has returned 53pc over the past three years.

Alan Brierley of Collins Stewart tipped infrastructure funds as a buy thanks to their low correlation with other asset classes.

"Infrastructure investment trusts continue to go from strength to strength, with growth underpinned by superior risk-adjusted return characteristics and attractive, sustainable and growing dividends," he said.

"The power of compounding solid absolute returns has delivered significant outperformance of other asset classes. Given genuinely low correlations with other asset classes and proven capital preservation qualities, they have an important role to play in improving portfolio diversification."

Tom Biggar of TQ Invest said there were unprecedented investment opportunities in emerging market infrastructure – with spending projects forecast to reach more than $21 trillion.

The move of populations from rural to urban environments – more than 350m are forecast to move between 2010 and 2015, according to the World Bank – means increased demand for infrastructure.

But not everyone is in favour of the sector. Alan Steel, who runs his own asset management company, said investors should just stick to income funds.

"I don't understand why you would want to invest in infrastructure when you can get an income from income funds – funds that have managers with a long-term track record and stable yields."

Mr Steel recommended Invesco Perpetual Income, which is yielding 4.4pc, and Neptune Income, paying 4.8pc. For regular income he recommended Jupiter Monthly Income. He advised a defensive spread between UK and global income funds.

"The companies held in M & G's Global Dividend fund have grown their dividends for at least 25 years – a couple have managed it for nearly 40. And at these prices you will get capital appreciation too," he said.

Mr Peters admitted that there were potential disadvantages to the infrastructure sector. As investors are hungry for quality income, infrastructure funds are currently trading at a premium, making them costly. He said valuations were sensitive to movements in gilt yields and interest rates and tipped INPP or 3i Infrastructure in preference to HICL or John Laing.

Mr Peter said investors should not be put off by the news that new PFI contracts would cease, and that infrastructure offered investors a real alternative to the lacklustre bond market.

"There has been a lot of comment in the press about the future for PFI and the costs they incur. While the future contracts will change for sure, we continue to see a role for private sector funding, and existing assets owned by these funds should not be affected."